links for 2009-08-12

Summers: Social Security Overhaul Likely

Saying that Social Security reform is on the agenda is not the way to get the elderly on your side for health care reform:

Overhauling Social Security on the Agenda, Summers Says, by Edmund L. Andrews: About the same time that President Obama was at a town-hall meeting in New Hampshire, pitching the benefits of a health care overhaul, one of his top economic advisers was fielding questions about what might come next.

Lawrence Summers ... told a conference of economists in Washington on Tuesday that President Obama would probably start addressing the needs of Social Security before the end of his term.

“Over the course of the president’s term, the president will, I am confident, address Social Security,” Mr. Summers said in a response to a question at a conference of the National Bureau of Economic Research.

Mr. Summers said the top priority in overhauling Social Security would be to make sure that people could rely on their benefits. ... Mr. Summers seemed intent on signaling that Mr. Obama’s idea of “reform” would be to strengthen the program rather rather than to partly privatize it.

But Mr. Summers said the big cost problems for the government are in health care. Reducing the growth of Medicare costs by just a few tenths of a percent per year, he said, would over a period of decades save enough money to fill the projected shortfall for Social Security. ...

Why announce this now? Will 'cut health care costs to save Social Security' work as a message?

Paul Krugman and Charlie Stross

A few passages from a much longer discussion between Paul Krugman and science fiction author Charlie Stross (via): 

Anticipation World Con, Transcription by Edwin Steussy: ...PK: [T]his is different for me, but it should be a lot of fun. … What do you really think the world is going to look like, say, 30 years from now? ... I was thinking about this coming up – and thinking that – maybe it was just my age or something, but things don’t seem to have changed as much in the last 30 years as myself as a sci-fi reader would have expected them to. And I don’t know if I’m missing something... There is no question that things have changed, but ... I still have the sense that the transformation in the quality of life that I thought would be happening by now... If I can veer off into something I allegedly know something about, in case you haven’t heard, we have a global economic crisis. What’s amazing about it is how much it’s traditional.

CS: A good, old fashion banking crisis.

PK: They happen to involve complicated institutions that are not called banks, they do rely on IT, you no longer have to have rows of tellers to provide people fast access to cash, not subject to standard bank regulation, they can manage to have bank runs all the same. You read John Maynard Keynes‘ The Great Slump of 1930, and with just a few words changed it’s a very fine description of what’s happened to the world in the past year. We haven’t actually changed the structure of how we do things to anything like the extent one might have imagined.

CS: Working hypothesis. It’s a working hypothesis that I’m trying to get my head around. Back to 1970-ish, do you remember the book by Alvin Toffler called Future Shock?

PK: Yeah.

CS: My working hypothesis is that we are living in a future shocked civilization in fact the future shocked globe. There is a lot of evidence of it all around. The ascendancy of religious fundamentalism in all sorts of cultures is one particular response. People don’t like rapid change when it’s applied to them against their will, when it’s coercive, and when people don’t like something, an external stimulus, they tend to kick back against it. Religious fundamentalism boils down very largely to one thing: certainty in life. ... And to people who are disoriented and distressed by the way the world around them is changing that’s got to be a source of … a very attractive offer of mental stability.

PK: You know, I think this is where being an American makes a difference. And knowing that we’ve had these crazies with us consistently as a major feature of our political scene. Going back to certainly the 1920’s.

CS: Don’t they seem to be a bit louder now?

PK: They have their ups and downs. But, a lot of what we see now is … read H.L. Menken on the fundamentalists and it’s the same … it sounds very similar. In a lot of ways, I think that the modern world began in the 20’s with radio and the penetration of mass culture into places that previously had been comfortable with their bibles. So this is not so new. They got louder … I’m about to go off onto a discourse on US … it’s not clear that the fundamentalists got any more fundamentalist … what happened was that we had a political shift in the United States at least that empowered them … the break up of the old weird coalition between basically Northern labor unions and Southern segregationists … created a place where the religious right had power again but I don’t think that there’s … I’m about to switch sides here … there has been a rise in religious fundamentalism among unusual groups there are … amazing number of relatives of mine who have ... kids ... have suddenly turned orthodox and that was not something anyone quite envisioned … maybe some kind of future shock.

CS: I’ve noticed in the UK over the past decade there has been an increasing (small “c”) conservatism in the electorate fostered by a feedback loop with some newspapers. Standard headline is, “Threatening entity here going to do something hideous to you.”

PK: That’s my column for tomorrow’s New York Times actually. ...

...

CS: There’s a huge latency in ... technology. ...

PK: ...There’s a favorite story about this among the economic historians and it’s about electricity. Which is that electrification … widespread electrification is a phenomenon of the 1880’s and particularly factories were electrified in the 1880’s and it did nothing much for productivity because they were still building factories the way … a 19th century factory was a five story brick building … very tight spaces … which has a steam engine in the basement … driving trains and pulleys and shafts and it took about 30 years for them to figure out that, hey!, with each machine having it’s own electric motor, we can have a wide spread out single story floor plan with lots of space and we don’t have to be moving stuff up and down these stairs and we can have plenty of room for material flow and … we saw a little bit of that in IT, but the thing was it was terribly disappointing because although it actually does show in the GDP numbers, what was the first place where people really figured out what do with IT in a way that was productive, and the answer was Wal-mart. It turns out that all this unglamorous stuff like inventory management, basically knowing what exactly is left on the shelves the moment it is checked out of the counter being able to plan your whole system for something big box stores brought in and actually you can see that’s where the GDP growth …

CS: Logistics is vastly underrated. It’s invisible.

PK: That’s right. That’s the other thing, with globalization … about the outsourcing … about the Internet and the IT … but that’s a relatively minor thing so far, probably much bigger in ten years so, but the big thing was the freight container.

CS: Oh yeah, the freight container and the fork lift and pallet.

PK: Right. And the big cranes and the bar code on the side of the container.

CS: ...I think one of the things logistics is going to … well, computers are going to give us, is much tauter supply chains between production and consumption.

PK: That’s by the way one of the mysteries … we don’t quite know why there’s so much stuff being shipped long distances, particularly … its one thing when we’re talking about oil because oil is where it is, it has to be shipped to get to other places, but … there was a time, again thinking of the United States, a time when we knew what Detroit did for a living, we knew Troy, New York was the detachable collar and cuff center of America and all these local specializations and you could explain why stuff was being shipped back and forth. These days, it’s very very hard to figure out what’s different about the economies of different cities and so if … why is there so much … who are all those people on the plane today. Why were they traveling and … better still, when you’re flying between Cleveland and Atlanta, what is it that Cleveland has that Atlanta needs? What is it that Atlanta has that Cleveland needs? Actually, what is that Atlanta has that anyone needs? I actually did try to figure out what Atlanta’s economy is about … it seems to be about the airport. We’re not quite getting it. ... If we can all have short supply chains why don’t we have that now for all of the services that cities generate and yet we have all of this trucking going back and forth among seemingly very similar US cities.

CS: Because I reckon that complexity, the number of different components, the number of different of different specialties that you need to run a modern, high tech civilization has mushroomed by orders of magnitude over even the past 50 years. And all of this stuff is really small, very, very specialized, there’s only a very few people who do it in one place and it has to get shipped about even though it looks similar.

PK: That’s the working hypothesis, something like that. ...

I think it's difficult to see how much things have changed when you are living through it. It's like kids. When you are with them everyday, you hardly notice that they are changing, but if you don't see them for several years, the large amount of change is obvious. I don't think we fully realize yet how much of a revolution information technology - the internet in particular - is bringing about. It's not as spectacularly obvious as underground cities or flying cars, but I think the change it brings is far more pervasive both socially and economically. In the future, when people look back at this time period, they will see it as a time that brought about vast change to the world, on the order of the industrial revolution. The change has not yet been fully realized, we are still getting wired up both at the extensive and intensive margins (i.e. the technology is still spreading and improving, and we are increasingly interconnecting ourselves with links, RSS feeds, Facebook, Twitter, and the like), but even so, the changes that have occurred already are far more exensive than we understand as we live through it. I was thinking about getting old the other day, and one of the things that disappoints me most about the prospect of my time ending is that I won't get to see how this all plays out. I think we are living through a time of vast, important change and what the world will look like hundreds and thousands of years from now fascinates me. I wish I could stick around to see what happens.

The Reconstruction of Authority

David Warsh on how attitudes toward authority have changed over time:

Public Turmoil, Then and Now, Economic Principals: ...The protests of the ’60s and ’70s – not just in the West, but in the communist countries as well – were mainly criticisms of overbearing governments, dedicated to modernist principles of growth by means of administration and planning, but subject to capture by special interests of every sort, and often completely uninterested in obtaining the consent of the governed. The dissent of that time was remarkably effective. In the end Jane Jacobs and Milton Friedman (and Rachel Carson, Martin Luther King, Betty Friedan and the Stonewall generation, for that matter) had pretty much the same effect. The world has become much more alert to the problems involved when regulation is top-down.

Today, we are in the early stages of very different times – an era of reconstruction of authority. The broad symbols of this are everywhere: an American president seeking to govern by bipartisan consensus, a Russian premier bare-chested on horseback in a Siberian stream, Chinese central bankers chiding their American counterparts about responsible borrowing (while conjuring a worrisome financial asset bubble of their own). The subtler mechanics of impending changes – in health care, in climate change, in national security – are harder to grasp. ...

Meanwhile, don’t worry overmuch about those raucous meetings, as unpleasant as they are. They’re a sideshow, further signs of the breakup of the traditional Republican Party. It will take another generation to work out the colossal differences of opinion that exist today within its ranks. Something new and worthwhile will replace today’s GOP, though not without a good deal more travail. But that’s a story for another day.

links for 2009-08-11

“An International Comparison of Small Business Employment”

John Schmitt and Nathan Lane of the CEPR:

An International Comparison of Small Business Employment, by John Schmitt and Nathan Lane, CEPR: Contrary to popular perceptions, the United States has a much smaller small-business sector (as a share of total employment) than other countries at a comparable level of economic development, according to this new CEPR report. The authors observe that the undersized U.S. small business sector is consistent with the view that high health care costs discourage small business formation, since start-ups in other countries can tap into government-funded health care systems. [Note: Click on figures for larger versions]

Cepr1

Cepr2

Cepr3

There's another factor that could also be contributing besides competitive disadvantages with countries that have government funded health care systems. A more extensive social safety net can reduce the risk of attempts at entrepreneurship. If there is an extensive social safety net to fall back upon if things don't work out, you might be more willing to quit the job you hate (the one with health insurance for the kids) and sink everything you have into a small business that you've always wanted to run. But I'm not sure the data above support this interpretation, i.e. that there is an obvious positive association between the strength of social insurance and the prevalence of small business. But it is highly suggestive, and regressions that control for other cross-country differences could help to settle the issue. In any case, one thing is clear, according to these measurements the US has low numbers relative to other countries in the sample.

“Astro-Turf Trolls for the Blogosphere”

Great. Organized, paid blog trolls:

Make no mistake: GOP is paying trolls to "blog attack", by Politics and Technology: This is unbelievable. We always knew that there were right-wing political hacks trolling the blogosphere, but this is a new low.

There's a company called Advantage Consultants that's offering up "professional blog warriors" to "flood the zone" with comments. In short, astro-turf trolls for the blogosphere.

Click to zoom on their ad..., but here's the text:

Are you ready for a blog attack?

Get ahead of your opponent with Professional Blog Warriors.

Be prepared to "flood the zone" with comments from professionals who are ready to put your talking points on the blogosphere 24/7.

Whether it's defense or offense, Advantage Consultants has a dedicated team of experienced blog warriors ready to advance your candidate or campaign.

Why wait for the attack? Launch your attack with a battery of blog and forum comments aimed at all media and blog sites in your district.

Contact us today and let us show you the Advantage in professional blog warfare.

 ...Incidentally, who are these people? Who is Advantage Consultants? Their president is Doug Guetzloe, a right-wing radio host and anti-tax activist in Florida.

The marketplace of ideas is far from ideal. This goes on in a variety of different formats, people are paid to call into radio shows, to write letters to the editor at local papers, to attend public meetings, if there's a public forum on important issues you can bet someone, somewhere is doing their best to figure out how to manipulate the discussion in their favor. This is just the extension of an old technique to a new format (e.g. here's the same consulting group explaining how to manipulate talk radio).

But the basic dishonesty of it all bugs me.

Stabilization Policy and Intertemporal Shifts in Output and Consumption

I've seen lots of objections to the Cash for Clunkers program based upon the fact that all the program does is shift consumption intertemporally, it doesn't actually create sales that wouldn't have occurred anyway.

But that is not, in and of itself, a valid objection. Shaving the peaks in output and consumption to fill the valleys stabilizes the economy. When the economy is in recession, creating brand new things that wouldn't have existed otherwise to lift the economy back toward full employment is preferred, but generally there aren't enough opportunities along these lines to give the economy the help it needs. In the cases where we cannot create enough new output and consumption to bring the economy back to health, moving consumption from a time when the economy is overheated to a time when it is underperforming helps by bringing both time periods closer to the long-run trend.

Now, Cash for Clunkers is not the the best way to shift consumption from the future to the present, or anywhere close since the intertemporal shifting is generally only for a month or two rather than from good times to bad, so this should not be interpreted as a defense of the program on this basis. But that doesn't mean the idea of intertemporal shifting is inherently flawed.

There seems to be an idea that policy must create something new, that simply rearranging consumption intertemporally is of no value. But there is value in avoiding large cyclical swings in the economy, i.e. value in stability, and when we have the opportunity to shave the peak of housing and other booms - times when the overheating is dangerous as it could result in bubbles, inflation, and other problems - and then use the "shavings" to fill the troughs of recessions, we should do so.

Paul Krugman: Averting the Worst

[Note: The actual column, "Averting the Worst" by Paul Krugman, is here.]

*****

I heard you say that we aren’t going to have a second Great Depression. What saved us?

The answer, basically, is Big Government.

So the government fixed things? Does everyone go back to work tomorrow?

Just to be clear: the economic situation remains terrible. We haven’t yet reached the point at which things are actually improving; for now, all we have to celebrate are indications that things are getting worse more slowly.

We're still skidding towards the cliff, but we'll stop in time? I'll feel better when we're actually stopped, or better yet, headed in the other direction.

The latest flurry of economic reports suggests that the economy has backed up several paces from the edge of the abyss. A few months ago the possibility of falling into the abyss seemed all too real.

So what was so special about the way government reacted?

Probably the most important aspect of the government’s role in this crisis isn’t what it has done, but what it hasn’t done.

Okay, then what didn't the government do that was so special?

Unlike the private sector, the federal government hasn’t slashed spending as its income has fallen. (State and local governments are a different story.) Tax receipts are way down, but Social Security checks are still going out; Medicare is still covering hospital bills; federal employees, from judges to park rangers to soldiers, are still being paid.

All of this has helped support the economy in its time of need, in a way that didn’t happen back in 1930.

This means that budget deficits — which are a bad thing in normal times — are actually a good thing right now.

I can buy that the government had an “automatic” stabilizing effect through its normal expenditures and by supporting increased demand for programs such as unemployment insurance, food stamps, those sorts of things. I can also see how running a deficit is the only way to support these programs. But the financial bailout, surely you aren't going to tell me that was helpful too? Look how it was handled!

You can argue (and I would) that the bailouts of financial firms could and should have been handled better, that taxpayers have paid too much and received too little. Yet it’s possible to be dissatisfied, even angry, about the way the financial bailouts have worked while acknowledging that without these bailouts things would have been much worse.

The point is that this time, unlike in the 1930s, the government didn’t take a hands-off attitude while much of the banking system collapsed. And that’s another reason we’re not living through Great Depression II.

So what you are telling me is that the bailout worked, and was necessary, but we could have bailed out the system in a way that cost taxpayers less and the people responsible for the problems more? You're right about it being possible to be dissatisfied even though it worked. Anyway, since we're talking about poorly structured programs, above when you talked about automatic stabilizers, you didn't mention the stimulus package. Is that because it hasn't helped much yet?

From the beginning, I argued that the American Recovery and Reinvestment Act, a k a the Obama stimulus plan, was too small. Nonetheless, reasonable estimates suggest that around a million more Americans are working now than would have been employed without that plan — a number that will grow over time — and that the stimulus has played a significant role in pulling the economy out of its free fall.

So automatic stabilizers, an imperfect but effective enough financial bailout, and an imperfect but at least helpful stimulus package are all working together to overcome the problems in the economy?

Ronald Reagan was wrong: sometimes the private sector is the problem, and government is the solution.

That's not the only thing he was wrong about.

And aren’t you glad that right now the government is being run by people who don’t hate government?

Speaking of which, how do you think things would have been different if McCain had won the election?

We don’t know what the economic policies of a McCain-Palin administration would have been. We do know, however, what Republicans in opposition have been saying — and it boils down to demanding that the government stop standing in the way of a possible depression.

Yeah, Republicans aren't exactly fans of the stimulus package. They'd reverse it right now if they could.

I’m not just talking about opposition to the stimulus. Leading Republicans want to do away with automatic stabilizers, too. Back in March, John Boehner, the House minority leader, declared that since families were suffering, "it’s time for government to tighten their belts and show the American people that we ‘get’ it." Fortunately, his advice was ignored.

Ignoring Boehner's advice is a good idea in general. Ignoring him saved the day.

I’m still very worried about the economy.

Why?

There’s still, I fear, a substantial chance that unemployment will remain high for a very long time. But we appear to have averted the worst: utter catastrophe no longer seems likely.

And Big Government, run by people who understand its virtues, is the reason why.

links for 2009-08-10

Fed Watch: The Recovery Edges Forward

Tim Duy reviews the state of the economy in anticipation of the Federal Reserve meeting scheduled for Tuesday and Wednesday of this week:

The Recovery Edges Forward, by Tim Duy: Data flow continues to support those who argue that if the recession is not already over as of July, it soon will be. The July jobs report - while not exactly cheery news for those still losing their jobs - is another clear indicator that the employment picture is turning. Still, excitement over the end of the recession aside, the data also reveal that the economy is recovering in fits and starts, with tell-tale signals that the consumer orgy of this decade is not likely to be repeated.

The July employment report in many ways spoke for itself. Possibly most important is the clear improvement in the pace of job losses:

FEDWATCH0809092

This serves as confirmation of what we already knew from initial claims - the worst damage to the job market is in the rearview mirror. Other positive signs included a rise in manufacturing hours and stability in aggregate hours. To be sure, not all is perfect. The decline in the unemployment rate was driven by an exodus from the labor force - not exactly a sign of improving conditions. And a key leading indicator of employment, temporary help payrolls, continues to decline. If the recession did in fact end in June, and we see evidence of that end in the July industrial production report to be released this week, the decline in temporary help employment is clearly a disappointment. Indeed, coupled with rising production, it would simply reek of jobless recovery.

Other data supported the notion of weak recovery as well. While industrial activity may be close to turning a corner on the back of inventory reduction and the cash for clunkers program, not all is well in the service sector. The ISM read on nonmanufacturing activity actually edged downward for the month, with declines in not only the headline number, but also business activity, new orders, and employment. Better than the freefall of last year, but nothing to suggest that a V-shaped recovery is imminent.

Perhaps the lack of enthusiasm in the service sector is a reflection of what is clearly a subdued consumer. The June personal income and outlays report reveals that consumer spending declined in for the month:

FEDWATCH0809091

The impact of a weakened consumer is evident in a spate of stories and data during the week. For example, the first read on retail sales for July:

Retailers endured another tough month in July -- the worst since January -- as weaker consumer spending signaled a tough time for back-to-school sales, the second-biggest retail season after Christmas.

And note that where consumer activity is occurring, it tends to be at a lower price point:

Procter & Gamble Co., under assault by penny-pinching consumers, has quietly rolled out a version of Tide detergent that the company freely admits isn't "new and improved."

The product, Tide Basic, is currently for sale in about 100 stores throughout the South. It lacks some of the cleaning capabilities of the iconic brand -- and costs about 20% less. Its very existence is one of the most telling signs to date of how the sour U.S. economy is forcing mass marketers to shift course. On Wednesday, the company reported an 18% plunge in fiscal fourth-quarter profits as sales of its premium-priced brands shrank amid tightened consumer budgets.

The decision to develop Tide Basic didn't come easily. For decades, P&G had held fast to a strategy of promoting new features to convince shoppers to pay a premium for detergent, shampoo and other household staples. Then, as cheaper store brands gained traction in the aisles, P&G began offering lower-priced versions of some products -- Charmin toilet paper, Bounty paper towels -- to suit leaner budgets.

The trend is not limited to consumer staples. In what I think is an underreported story, the new housing market too is shifting toward the low end:

Frugal first-time buyers are driving the new-home market with purchases of low-priced houses with no frills. Sales of new homes costing less than $200,000 jumped to 47 percent of all transactions in June, up from 39 percent in May, U.S. Commerce Department data show. Homes under $200,000 accounted for almost half of the sales in the first six months of this year, the biggest share for a first half in five years.

It is often forgotten that the composition of new home construction is likely to change as builders shift to producing what people can actually afford, which is very different from what was being produced during the height of the housing bubble. The new housing will yield thinner profit margins for everyone in the supply chain, and will not generate as much wealth when they do appreciate at some point in the future.  Moreover, a rebounding new home market for all housing types will place severe downward pressure on existing home prices, as builders will benefit from now lower land and construction costs. The point of which is that a recovery in new home sales is not a recovery for housing or the economy overall.

And if you had any residual doubt that household spending was still challenged, that doubt should be dispelled by the Federal Reserve read on consumer credit:

Consumer credit in the U.S. declined in June for a fifth straight month as banks maintained tough lending terms and households remained reluctant to borrow money for major purchases.

Consumer credit fell $10.3 billion, or 4.92 percent at an annual rate, to $2.5 trillion, according to a Federal Reserve report released today in Washington. Credit dropped by $5.38 billion in May, more than previously estimated. The series of declines is the longest since 1991.

To be sure, the pace of the decline should lessen in July as the impact of the cash for clunkers sales becomes more evident, but this would really be further evidence of consumer weakness - the only way to induce households to loosen the purse strings is to give them free money. Like the improvements seen in new home sales, an ongoing testament to the importance of government spending in keeping the economy afloat. It is not clear that all sectors realize that importance. An interesting local tidbit:

Production has resumed at Monaco RV, eight months after the plant was idled, a spokesman said Thursday.

About 400 workers are back at work at the Coburg factory, producing about seven recreational vehicles per day, said Roy Wiley, spokesman for Illinois-based Navistar International, the new parent company of Monaco RV. He said he wasn’t sure if workers were building towable RVs, motor coaches or a combination of both.

Even though there are no indications that the RV market has begun to recover, Navistar decided to resume production at the plant about two weeks ago because “you need inventory,” Wiley said.

Apparently, Navistar plans to increase inventory on the "if you build it they will buy it" philosophy. But like overpriced housing and luxury goods, RV sales are dependent on cheap credit and bad judgment. At least with a house you have hope of recovering your nominal losses if you hold on long enough; not so with RVs, which are only an exercise in depreciation tables. 

The pattern of data and anecdotal evidence on the consumer is that the worst fears of a return to Depression-era spending patterns have not been realized, households have measurably changed their behavior, which coupled with what are likely permanently stricter underwriting conditions, point to a very real structural change in the evolution of economic activity going forward. It is simply increasingly difficult to believe we can return to a pattern of growth dependent on escalating importance of consumer spending in the mix of economic activity. Structural change is at hand, which will leave some dangerous economic waters to navigate.

Which leads us to the policy event of the week, the Federal Reserve meeting scheduled for Tuesday and Wednesday. The subsequent statement will have to address the improving economic data without setting expectations that a rate hike is imminent, or even under consideration for early next year as some suspect. To be sure, there will be some V-shapers on the FOMC looking to roll back policy accommodation at first hint of economic growth. But I have to imagine that Federal Reserve Chairman Ben Bernanke walked away with not one, but two basic rules from his studies on the Great Depression and Japan. The first is to respond forcefully at the first stages of a financial crisis. The second is to recognize the fragility of the subsequent recovery and NOT rush to normalize policy, thereby setting the stage for stop-start policy efforts. No one should be under the delusion that the current economic environment is the product of anything other than the massive efforts of federal authorities to keep the system afloat. Low interest rates, support of securitization markets, free money for cars and houses, fiscal stimulus, etc. Bernanke simply will not be inclined to rock the boat at such an early stage of the recovery.

What the Fed is likely to signal is that they do not intend to extend the Treasury purchase program at its expiration:

The Federal Reserve is set to halt its purchases of up to $300 billion in U.S. Treasuries in mid- September as scheduled, and will probably announce the decision next week, two former central bank governors said.

Still, I would not discount the possibility that the program could make a fresh appearance in the future; the future of monetary policy is dependent on the path of job growth. Six months of jobless recovery as the economy limps along could easily prompt the Fed into additional easing. Remember, that was the pattern in the wake of the 2001 recession, a recession that did not end for many until the housing bubble took hold. It is tough to see a fresh domestic bubble emerging, and thus tough to see how sustainable, organic growth develops. And thus tough to see a Fed not more inclined to offer additional gas rather than step on the brake.

Bottom Line: For those still fretting that the economy remains poised for the ultimate end-times collapse, you need to remember the following: In aggregate, nothing truly bad will happen as long as the Federal Reserve can print money and the US Treasury can spend it. We simply have not hit that wall yet (although one can see it coming, as the history of monetary policy for the last two decades is one of diminishing returns - it apparently takes more to accomplish less).  At the same token, acceptance of the reality that the recession is set to end does not oblige one to adopt a V-shaped outlook. Far from it, as patterns of consumer spending and labor market activity, not to mention the undeniable impact of government support, all point to a tepid recovery characterized by a jobless recession. Such an outcome, however, will not be proven or denied by the end of the year at the earliest.

“The White House’s Deal With Big Pharma Undermines Democracy”

Robert Reich says the administration's promise not to use the government's purchasing power to lower the price of drugs in return for a large, pharmaceutical industry sponsored ad campaign in support of health care reform undercuts and threatens the democratic process:

How the White House's Deal With Big Pharma Undermines Democracy, by Robert Reich: I'm a strong supporter of universal health insurance, and a fan of the Obama administration. But I'm appalled by the deal the White House has made with the pharmaceutical industry's lobbying arm to buy their support.

Last week,... the White House confirmed it has promised Big Pharma that any healthcare legislation will bar the government from using its huge purchasing power to negotiate lower drug prices. That's basically the same deal George W. Bush struck in getting the Medicare drug benefit, and it's proven a bonanza for the drug industry. ... Let me remind you: Any bonanza for the drug industry means higher health-care costs for the rest of us...

In return, Big Pharma isn't just supporting universal health care. It's also spending a lots of money on TV and radio advertising... Big Pharma has budgeted $150 million for TV ads promoting universal health insurance, starting this August (that's more money than John McCain spent on TV advertising in last year's presidential campaign), after having already spent a bundle through advocacy groups like Healthy Economies Now and Families USA.

I want universal health insurance. And having had a front-row seat in 1994 when Big Pharma and the rest of the health-industry complex went to battle against it, I can tell you first hand how big and effective the onslaught can be. So I appreciate Big Pharma's support this time around...

But I also care about democracy, and the deal between Big Pharma and the White House frankly worries me. It's bad enough when industry lobbyists extract concessions from members of Congress, which happens all the time. But... [a]n industry is using its capacity to threaten or prevent legislation as a means of altering that legislation for its own benefit ... at the highest reaches of our government, in the office of the President.

When the industry support comes with an industry-sponsored ad campaign in favor of that legislation, the threat to democracy is even greater. Citizens end up paying for advertisements designed to persuade them that the legislation is in their interest. In this case, those payments come in the form of drug prices that will be higher than otherwise...

I don't want to be puritanical about all this. Politics is a rough game... Perhaps the White House deal with Big Pharma is a necessary step to get anything resembling universal health insurance. But if that's the case, our democracy is in terrible shape. How soon until big industries ... have become so politically powerful that secret White House-industry deals ... are prerequisites to any important legislation? When will it become standard practice that such deals come with hundreds of millions of dollars of industry-sponsored TV advertising designed to persuade the public...? (Any Democrats and progressives ... should ask themselves how they'll feel when a Republican White House cuts such deals to advance its own legislative priorities.)

We're on a precarious road -- and wherever it leads, it's not toward democracy.

“A Missed Opportunity on Climate Change”

In discussing proposed climate change legislation below, Greg Mankiw says:

To those who view climate change as an impending catastrophe and the distorting effects of the tax system as a mere annoyance, an imperfect bill is better than none at all. To those not fully convinced of the enormity of global warming but deeply worried about the adverse effects of high current and prospective tax rates, the bill is a step in the wrong direction.

He then goes on to say "As for me, I hope the president refuses to sign a bill that fails to auction most of the allowances..., sometimes good is not good enough" which, given his categorization of those supporting and opposing the bill, I interpret to mean that he is more worried about distortions from taxes than he is about global warming:

A Missed Opportunity on Climate Change, by N. Gregory Mankiw, Commentary, NY Times: During the presidential campaign of 2008, Barack Obama distinguished himself on the economics of climate change, speaking far more sensibly about the issue than most of his rivals. Unfortunately, now that he is president, Mr. Obama may sign a climate bill that falls far short of his aspirations. Indeed, the legislation making its way to his desk could well be worse than nothing at all. ...

The textbook solution for dealing with negative externalities is to use the tax system to align private incentives with social costs and benefits. ... A carbon tax is the remedy for climate change that wins overwhelming support among economists and policy wonks.

When he was still a candidate, Mr. Obama did not exactly endorse a carbon tax. He wanted to be elected... What Mr. Obama proposed was a cap-and-trade system for carbon, with all the allowances sold at auction. ... Such a system is tantamount to a carbon tax. The auction price of an emission right is effectively a tax on carbon. ...

So far, so good. The problem occurred as this sensible idea made the trip from the campaign trail through the legislative process. Rather than auctioning the carbon allowances, the bill that recently passed the House would give most of them away to powerful special interests.

The numbers involved are not trivial. From Congressional Budget Office estimates, one can calculate that if all the allowances were auctioned, the government could raise $989 billion in proceeds over 10 years. But in the bill as written, the auction proceeds are only $276 billion. ...

How much does it matter? For the purpose of efficiently allocating the carbon rights, it doesn’t. Even if these rights are handed out on political rather than economic grounds, the “trade” part of “cap and trade” will take care of the rest. ...

The problem arises in how the climate policy interacts with the overall tax system. ... The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans...

The hard question is whether, on net, such a policy is good or bad. Here you can find policy wonks on both sides. To those who view climate change as an impending catastrophe and the distorting effects of the tax system as a mere annoyance, an imperfect bill is better than none at all. To those not fully convinced of the enormity of global warming but deeply worried about the adverse effects of high current and prospective tax rates, the bill is a step in the wrong direction.

What everyone should agree on is that the legislation making its way through Congress is a missed opportunity. President Obama knows what a good climate bill would look like. But despite his immense popularity and personal charisma, he appears unable to persuade Congress to go along.

As for me, I hope the president refuses to sign a bill that fails to auction most of the allowances. Some might say a veto would make the best the enemy of the good. But sometimes good is not good enough.

What he doesn't mention, and I'm not sure why, is that the permit giveaways are scheduled to end after after 10-15 years. That's not as good as auctioning the permits from day one, but it does put a plan for auctions in place. So in the long-run, the intent is to auction 100% of the permits just as Greg desires, the giveaways at the beginning are an attempt to get the bill passed. There are lots of problems with the bill as currently formulated, and a key consideration is how credible you view the promise to auction permits in the future. Going on a diet tomorrow is easy to plan, but when tomorrow comes will the plan be executed? I hope so, but have my doubts.

Solow: Dumb and Dumber in Macroeconomics

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Continuing with the discussion on the state of macroeconomics, this is Robert Solow from an October 25, 2003 address at Joe Stiglitz' 60th birthday conference. Solow gets extra credit for saying these things before the crisis hit, e.g. " I start from the presumption that we want macroeconomics to account for the occasional aggregative pathologies that beset modern capitalist economies, like recessions, intervals of stagnation, inflation, "stagflation," not to mention negative pathologies like unusually good times. A model that rules out pathologies by definition is unlikely to help." (Let me also point to a comment by Ping Chen at Free Exchange in response to the Lucas essay which I may highlight more explicitly later. Update: See also Jamie Galbraith's remarks at the Stiglitz conference):

Dumb and Dumber in Macroeconomics, by Robert M. Solow: So how did macroeconomics arrive at its current state? The answer might provide a lead as to where it ought to go.

The original impulse to look for better or more explicit micro foundations was probably reasonable. It overlooked the fact that macroeconomics as practiced by Keynes and Pigou was full of informal microfoundations. (I mention Pigou to disabuse everyone of the notion that this is some specifically Keynesian thing.) Generalizations about aggregative consumption-saving patterns, investment patterns, money-holding patterns were always rationalized by plausible statements about individual--and, to some extent, market--behavior. But some formalization of the connection was a good idea. What emerged was not a good idea. The preferred model has a single representative consumer optimizing over infinite time with perfect foresight or rational expectations, in an environment that realizes the resulting plans more or less flawlessly through perfectly competitive forward-looking markets for goods and labor, and perfectly flexible prices and wages.

How could anyone expect a sensible short-to-medium-run macroeconomics to come out of that set-up? My impression is that this approach (which seems now to be the mainstream, and certainly dominates the journals, if not the workaday world of macroeconomics) has had no empirical success; but that is not the point here. I start from the presumption that we want macroeconomics to account for the occasional aggregative pathologies that beset modern capitalist economies, like recessions, intervals of stagnation, inflation, "stagflation," not to mention negative pathologies like unusually good times. A model that rules out pathologies by definition is unlikely to help. It is always possible to claim that those "pathologies" are delusions, and the economy is merely adjusting optimally to some exogenous shock. But why should reasonable people accept this? During the past three years, unemployment has increased by three million with real wages stagnant and productivity growing, possibly abnormally fast. Capacity utilization has fallen by 10 percent, with trivial inflation and some prices falling. Real business investment in equipment peaked in the third quarter of 2000, fell by 20 percent to the first quarter of 2002, and has risen by a scant five percent since then. Is this a stagnation pattern? Does it reflect large-scale, perhaps irrational, overinvestment in the 1990s? Should it not be studied as such? Why should anyone take it as the solution of an Euler equation? It would not be hard to imagine a better path for the economy. Why should the burden of proof fall on those who see an ordinary standard pathology here? The odd thing is to regard this history as the working out of an other-worldly model.

What is needed for a better macroeconomics? My crude caricature of the Ramsey-based model suggests some of the gross implausibilities that need to be eliminated. The clearest candidate is the representative agent. Heterogeneity is the essence of a modern economy. In real life we worry about the relations between managers and shareowners, between banks and their borrowers, between workers and employers, between venture capitalists and entrepreneurs, you name it. We worry about those interfaces because they can and do go wrong, with likely macroeconomic consequences. We know for a fact that heterogeneous agents have different and sometimes conflicting goals, different information, different capacities to process it, different expectations, different beliefs about how the economy works. Representative-agent models exclude all this landscape, though it needs to be abstracted and included in macro-models.

I also doubt that universal rational expectations provide a useful framework for macroeconomics. One understands the appeal. Think of it this way: Herb Simon was surely right about bounded rationality; no one would deny that most economic agents are actually like that, and natural selection does not work fast enough to eliminate them. Why did the notion of "satisficing" never catch on? I think it is because the assumption of complete rationality tells the modeller what to do, whereas bounded rationality only tells the modeller what not to do. That is not helpful. Something similar is true about rational expectations. If there were a nice parametric family of alternative ways to model expectations, it might catch on. Most of us would happily go along with the notion of expectational equilibrium: if specific underlying expectations generate an outcome in which those expectations are systematically and non-trivially violated, that situation can not be an equilibrium. It is what happens then that needs thought. The situations that agents need to anticipate need not even be probabilistic, surely not stationary. The popular device used to be adaptive expectations; that may have been inadequate. Maybe this is a case for the application of psychological research (and sociological research as well, because the formation of expectations is a social process). Maybe experiments can be designed. Heterogeneity across agents and classes of agents is certainly important precisely here. One would like a simple, definite way to proceed, if that is possible. A good example of the sort of thing I mean is the way the Dixit-Stiglitz model made monopolistic competition easy. (The trouble is that we are dealing with an unobservable.)

Although I am going to take this back in a moment, it is certainly worthwhile mentioning the problems connected with real and/or nominal wage and price inflexibility and its sources in market structure, limitations of information, human nature, the specialness of zero, etc. This is an old issue in economics, macro and micro, and a lot of progress has been made in measuring and understanding it. Mere sluggishness is part of the picture, and that is easily modelled, but there is surely more that is less easily modelled. The devil finds work for idle hands to do, as you may have noticed.

Now here is a peculiar thing. When I was in advanced middle age, I suddenly woke up to the fact that my colleagues in macroeconomics, the ones I most admired, thought that the fundamental problem of macro theory was to understand how nominal events could have real consequences. This is just a way of stating some puzzle or puzzles about the sources for sticky wages and prices. This struck me as peculiar in two ways.

First of all, when I was even younger, nobody thought this was a puzzle. You only had to look around you to stumble on a hundred different reasons why various prices and factor prices should be much less than perfectly flexible. I once wrote, archly I admit, that the world has its reasons for not being Walrasian. Of course I soon realized that what macroeconomists wanted was a formal account of price stickiness that would fit comfortably into rational, optimizing models. OK, that is a harmless enough activity, especially if it is not taken too seriously. But price and wage stickiness themselves are not a major intellectual puzzle unless you insist on making them one.

The second peculiarity was that the path from nominal events to real consequences was not my idea of the fundamental problem of macro theory anyway. All along, I had been thinking--and this may be a Keynesian inheritance, though I doubt it because I may have picked it up from Gottfried Haberler's Prosperity and Depression, where my generation learned about business-cycle theory before "macroeconomics" had been invented--that the main problem was to understand why real shocks that took the economy out of some satisfactory equilibrium led to such a prolonged and sometimes unsatisfactory adjustment. These are medium-run problems--the capital stock moves--and there clearly are medium-run fluctuations in modern industrial economies. (This is documented for the U.S. in a recent paper by Comin and Gertler.)

Keynes claimed to have found the way to account for this: he thought he had a theory of unemployment equilibrium. The reason adjustment took so long, or never really happened, is that the depressed state was actually an equilibrium. Most of us today think that Keynes failed in that effort; he lacked the tools. The exception was the case of wage rigidity, but we knew that all along. In my youth, we thought that macro-pathologies were disequilibrium phenomena, and then the puzzle was: why is the process so slow?

This choice between equilibrium and disequilibrium thinking may be a false choice. If I drop a ripe watermelon from this 15th-floor window, I suppose the whole process from t0 to the mess on the sidewalk could be described as some sort of dynamic equilibrium. But that may not be the most fruitful--sorry--way to describe the falling-watermelon phenomenon.

So I would hope that macro theory could get back to focusing on the adaptation-to-real-disturbance problem, without falling into the implausibilities of real-business-cycle theory. (Even RBC theorists may fight their way out of that paper bag.) The Ur-Problem may be: start in a situation of growth equilibrium (not necessarily a steady state, but don't get me started on that one), and imagine a real shock, perhaps a failure of real effective demand (!). What happens next? That may be the story of the period from 2000 to now, the real shock having been massive overinvestment in response to unrealistic profit expectations (accompanied by accounting swindles, just to make Joe happy).

links for 2009-08-09

Machine-Sourcing

Gregory Clark sees a bleak future for the unskilled:

Tax and Spend, or Face The Consequences, by Gregory Clark, Commentary, Washington Post: At some point, the Great Recession will end. ... Whenever it happens, we will see that the downturn was but a minor blip in the long story of the economy. In the next chapter, abundance beckons -- for some. Advances in technology drive economic growth, and there is no sign that they are slackening. The American economy is likely to continue unabated on the upward path that began with the Industrial Revolution.

No, the economic problems of the future will not be about growth but about something more nettlesome: the ineluctable increase in the number of people with no marketable skills, and technology's role not as the antidote to social conflict, but as its instigator.

The battle will be over how to get the economy's winners to pay for an increasingly costly poor. ... In a future with higher taxes, the divide between rich and poor would be the central economic challenge.

For much of the past 200 years, unskilled workers benefited greatly from capitalism. Before the Industrial Revolution, for example, skilled construction workers earned 50 to 100 percent more than unskilled laborers; today, that premium has fallen to 33 percent in the United States. ...

Why have the unskilled fared so well? ...[M]achines ... even today ... cannot replace many of people's manipulative abilities, language skills and social awareness. The hamburger you eat at McDonald's is still put together and delivered to you by human hands; even a fast-food "associate" deploys an astonishing repertoire of spatial and language skills.

But in more recent decades, when average U.S. incomes roughly doubled, there has been little gain in the real earnings of the unskilled. And, more darkly, computer advances suggest these redoubts of human skill will sooner or later fall to machines. We may have already reached the historical peak in the earning power of low-skilled workers, and may look back on the mid-20th century as the great era of the common man.

I recently carried out a complicated phone transaction with United Airlines but never once spoke to a human; my mechanical interlocutor seemed no less capable than the Indian call-center operatives it replaced. Outsourcing to India and China may be only a brief historical interlude before the great outsourcing yet to come -- to machines. And as machines expand their domain, basic wages could easily fall so low that families cannot support themselves without public assistance. ...

So, how do we operate a society in which a large share of the population is socially needy but economically redundant? There is only one answer. You tax the winners ... to provide for the losers. ...

The United States was founded, essentially, on resistance to taxes, and to this day, an aversion to the grasping hand of the state seems fundamental to the American psyche. ... The conflicts to come are foreshadowed in California, where popular anti-tax sentiment has forced substantial reductions in medical care for the state's poorest children.

How can we avoid or minimize such conflicts? The Obama administration seeks to do so in part through a more cost-effective health-care system. ... But ... this will at best buy time before an inevitable crunch.

Others see education as a way out of this dystopia. The root problem is, after all, the widening of the income gap between the skilled and the unskilled. Can expanded education give the poorest the tools to resist the march of the machines? I'm skeptical. Already, much of the supposed improvement in high school and college graduation rates has come by asking less of graduates. ...

 In the end, we may be forced to learn to live in a United States where, by stealth, "from each according to his ability, to each according to his need" becomes the guiding principle of government -- or else confront growing, unattended poverty.

As the world develops in the long, long run, and as countries move from "developing" to "developed," I still see a chance that the growth in the demand for the services that the unskilled provide will outstrip the growth in the supply. That doesn't mean that the wealth gap won't continue to increase, and that there won't be any problems associated with the growing gap between those at the top and those at the bottom, but I'm not so sure that wages will fall such that absolute living standards will decline as predicted above. But nobody knows for sure what will happen, so what do you foresee?

links for 2009-08-08

“School for Scoundrels”

Paul Krugman reviews Justin Fox’s “Myth of the Rational Market”:

School for Scoundrels, Book Review by Paul Krugman: Last October, Alan Greenspan — who had spent years assuring investors that all was well with the American financial system — declared himself to be in a state of “shocked disbelief.” After all, the best and brightest had assured him our financial system was sound: “In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. . . . The whole intellectual edifice, however, collapsed in the summer of last year.”

Justin Fox’s “Myth of the Rational Market” brilliantly tells the story of how that edifice was built — and why so few were willing to acknowledge that it was a house built on sand. ...

Instead of focusing on the errors and abuses of the bankers, Fox ... tells the story of the professors who enabled those abuses under the banner of the financial theory known as the efficient-market hypothesis. ... Wall Street bought the ideas of the efficient-market theorists, in many cases literally: professors were lavishly paid to design complex financial strategies. And these strategies played a crucial role in the catastrophe that has now overtaken the world economy. ...

One of the great things about Fox’s writing is that he brings to it a real understanding of the sociology of the academic world. Above all, he gets the way in which one’s career, reputation, even sense of self-worth can end up being defined by a particular intellectual approach, so that supporters of the approach start to resemble fervent political activists — or members of a cult. In the case of finance theory, it happened especially fast...

In this sense, efficient-market acolytes were like any other academic movement. But unlike, say, deconstructionist literary theorists, finance professors had an enormous impact on the business world — and, not incidentally, some of them made a lot of money in the process. ...

I came away ... wondering if [the] underlying premise — that the current crisis will put an end to Panglossian views of financial markets — is right. Fox points out that academic belief in the perfection of financial markets survived the 1987 stock market crash and the bursting of the Internet bubble. Why should the reaction to the latest catastrophe be any different? In fact, what I hear from my finance professor friends is that there’s a lot less soul-searching under way than you might expect. And Wall Street’s appetite for complex strategies that sound clever — and can be sold to credulous investors — survived L.T.C.M.’s debacle; why can’t it survive this crisis, too?

My guess is that the myth of the rational market — a myth that is beautiful, comforting and, above all, lucrative — isn’t going away anytime soon.

Jobs Report Roundup

Most everything that can be said about the jobs report has already been said, so here's a roundup of various reactions. The point I want to emphasize is that it's far too soon for policymakers to begin easing up, they need to plan as though this is just a temporary aberration in the numbers. If that turns out to be wrong, then the plans do not need to be executed, but it's essential that we are ready to react if needed (e.g., though I think the political climate makes any action highly unlikely, policymakers could enact expenditures that kick in if the numbers in future reports fail to meet predetermined thresholds so that if there is sufficient improvement in the economy, the money won't be spent):

A remarkable jobs report, by Free Exchange: ...[T]he new nonfarm payroll employment data released by the Labor department this morning ...[shows] July job losses of just ... just 247,000... Just as remarkable, the unemployment rate actually declined, from 9.5% to 9.4%. This may end up being a short-term aberration, but it is a very unexpected and positive one.

Manufacturing employment fell by 52,000 for the month, the first time in ages that the number has been below 100,000. Health industry and government employment moved upward. Meanwhile, hours and earnings both rose, in a very good sign for the job market.

The news isn't all good. Since the recession began a total of 6.7 million jobs have been shed, and nearly 15 million people are currently out of work. And the number of long-term unemployed (those out of work for 27 weeks ore more) has reached 5 million—a third of those currently out of work. It is those workers that will have the most difficulty finding new employment, which is what must happen for the unemployment rate to decline to "normal" levels.

But this is one of the best economic reports America has seen to date...

Does this mean our problems are over?:

Has Unemployment Peaked?, by Brad DeLong: Almost surely not, alas. But a mere -247K on payroll employment is a good number--or, rather, a less-bad number than we all were expecting.

Economic glimmers of light, by Felix Salmon: What does it mean when employment and unemployment both move in the same direction? It might be an error in one of the two pretty fuzzy datasets, or it could be, as Agnes says this morning, a real turning point. That’s certainly what the bond market seems to think.

My feeling is that it’s far too early to say that unemployment has stopped rising, and that clearly nobody believes employment has stopped falling. ...

All the same, on such a happy day it would be churlish not to take some joy from today’s figures. The most vertiginous part of the economic plunge is clearly over, and there’s some real hope for (modest and painful) economic recovery going forwards...

The Least-Bad Jobs Report in a Long Time, by David Leonhardt: The story of today’s jobs report is pretty simple: given what was expected, it’s very good news. ... The one thing that doesn’t deserve much excitement is what will probably garner many of the headlines: the drop in the unemployment rate. It happened only because more people stopped looking for work and were thus ineligible to be counted as officially unemployed. The share of adults with jobs actually fell: to 59.4 percent, from 59.5 percent.

So the job market and the economy are still in bad shape. But, all in all, this was a very good report.

Anyone have any graphs?:

Employment Report: 247K Jobs Lost, 9.4% Unemployment Rate, by Calculated Risk: From the BLS:

Nonfarm payroll employment continued to decline in July (-247,000), and the unemployment rate was little changed at 9.4 percent, the U.S. Bureau of Labor Statistics reported today. The average monthly job loss for May through July (-331,000) was about half the average decline for November through April (-645,000). In July, job losses continued in many of the major industry sectors.

Employment Measures and Recessions Click on graph for larger image.

This graph shows the unemployment rate and the year over year change in employment vs. recessions.

Nonfarm payrolls decreased by 247,000 in July. The economy has lost almost 5.7 million jobs over the last year, and 6.66 million jobs during the 19 consecutive months of job losses.

The unemployment rate declined slightly to 9.4 percent.

Year over year employment is strongly negative.

Percent Job Losses During Recessions The second graph shows the job losses from the start of the employment recession, in percentage terms (as opposed to the number of jobs lost).

For the current recession, employment peaked in December 2007, and this recession was a slow starter (in terms of job losses and declines in GDP).

However job losses have really picked up over the last year, and the current recession is now the 2nd worst recession since WWII in percentage terms (and the 1948 recession recovered very quickly) - and also in terms of the unemployment rate (only early '80s recession was worse).

With fewer job losses ("only" a rate of 3 million job losses per year), and the dip in unemployment rate, this will be consider an improvement. It is still a weak employment report. Much more to come ...

[See also Employment-Population Ratio, Part Time Workers, Average Workweek, Unemployment: Stress Tests, Unemployed over 26 Weeks, Diffusion Index]

Employment Report, by spencer: The employment report was very encouraging.

Most importantly, aggregate hours worked were unchanged at 91.1 as compared to 104.1, 101.7 and 99.7 over the last three quarters. An unchanged reading is a massive improvement from the 8% to 9% rate of decline over the past three quarters. With positive productivity this impies that thrird quarter real GDP growth could easily be positive..

Moreover, the manufacturing work week rose from 39.5 to 39.8 hours and overtime hours were 2.9 hours versus 2.8 in the second quarter. Much of this was auto and confirms the other reports that at least auto output is rebounding. The hours worked together with productivity strongly impies that manufacturing output rose in July -- to be reported about mid-month. Moreover, the average workweek and overtime hours are traditional leading indicators.Wage growth improved, but not enough to reverse the sharp slowing in average hourly earnings growth.

With hours worked stable and hourly earnings rising average private weekly earnings rose from $611.49 to 614.34.
The improvement in weekly earnings is a welcome sign... Tax cuts are offsetting some of this weakness but a sustained recovery requires growth in real income.

The consensus forecast is for a very weak recovery. But the consensus forecast is always for a weak recovery. The actual historic record is for recoveries to be proportional to the recession. That is, severe recessions have strong recoveries and mild recessions have weak recoveries.
I'm not making a forecast or taking a position that the consensus is wrong, or that those who expect no recovery are wrong either. But at every bottom economists always have a long list of reasons why this recovery will be weak. And they are usually wrong. In 1981, I won the National Association of Business Economists annual forecasting contest by forecasting an average or normal recovery from the 1980 recession. It was the strongest forecast in the competition.Footnote. Despite the increase in the minimum wage the teenage unemployment rate actually fell.

What's going on with broader measures of unemployment?:

Jobs paradox?, by Paul Krugman: ...[H]ow do we measure unemployment? ... It comes, instead, from a survey in which people are asked whether they’re working and, if not, whether they’re looking for work. And what this month’s data show is a relatively large rise in the number of people “not in labor force” — neither working nor looking for work. That’s how the unemployment rate can fall even with fewer people working.

Isn’t U6, the broadest measure of unemployment, supposed to include people who are discouraged and stop looking? Yes — but at least according to the survey, that’s not the reason more people have dropped out of the work force.

Basically, though, what you need to bear in mind is that these are imperfect measures, subject to a fair bit of noise. When the trend in the labor market is very strong in either direction, the measures move together. But when you have the kind of scene we have now — the employment situation is drifting down, but not plunging — occasional mixed signals are likely. No big deal.

The basic story is that things are sort of stabilizing — but they’re definitely not improving yet.

Robert Reich is far from claiming victory:

The New Employment Numbers: Things are Worsening More Slowly, by Robert Reich: The economy is getting worse more slowly. That's just about the only clear reading that's coming from the economic reports, including this morning's important one on employment. ...

So let's be grateful that the economy is getting worse more slowly than it was. But don't be lured into thinking we're ever going back to where we were. Most of the jobs that have been lost are never coming back. New ones will replace some of them, eventually, but hardly all of them. The structure of the American economy is changing. We will emerge from all this with an economy that looks strikingly different from the one we had in 2007. More on this to come.

Justin Fox also notes "bad news" in the report:

Jobs! Jobs! Jobs!, by Justin Fox: ...The bad news is that there are no real signs of economic life in the details of the employment report, just a slowdown in the pace of losses in most of the big categories. The most significant job creation was in health care, which added 19,600 jobs. But that's nothing new, and it's not unmitigated good news—we want to cut health care spending, don't we? The federal government added 12,000 jobs, "arts, entertainment, and recreation" added 10,000 (who knew?). Oh, and the auto industry supposedly added 28,000 jobs, but I'll let the BLS explain that away:

In motor vehicles and parts, fewer workers than usual were laid off in July for seasonal retooling. ... In large part, July's seasonally-adjusted increase reflects the fact that previous job cuts had been so extensive that there were fewer workers to lay off during the seasonal shutdown.

The above numbers are seasonally adjusted—which is necessary to do, but adds lots of potential for weird statistical quirks like the auto employment increase. Without the seasonal adjustments, employment fell a whopping 1.3 million in the month. And there were 5.9 million fewer jobs in July 2009 than in July 2008. ...


The CBPP takes a look at long-term unemployment, and the news isn't good:

CBPP Statement, by Chad Stone: Today’s employment report shows that labor market conditions remain extremely harsh for job-seekers, generating a record level of long-term unemployment. One third of the unemployed (33.8 percent) have been looking for work for 27 weeks or more — the highest percentage ever recorded in data going back to 1948 and well above the peak reached in the severe 1981-82 recession (see Figure 1).

The report also shows that the deterioration in labor market conditions has slowed considerably from earlier this year, suggesting an economic recovery may be in sight. But that news must be tempered by the ongoing plight of the long-term unemployed....

Why did the unemployment rate fall?:

Why exactly did the unemployment rate fall?, by Rebeccas Wilder: Please correct me if I'm wrong. But the labor force is really big, 154,503,000 (see Table A on the BLS news release). Compared to that, the number of unemployed is really small, 14,462 (see the same table).

If the decline in number of unemployed, -267,000 was 63% the size of the decline in the labor force, -422, which shift is the dominant factor in the falling unemployment rate?

Unemployment rate = unemployed/labor force

I'd say the sizable shift in the really small numerator. Apparently, the AP does not think so:

One of the reasons the rate went down, however, was because hundreds of thousands of people left the labor force. Fewer people, though, did report being unemployed.

I'm pretty sure that this should read: The main reason that the unemployment rate went down was due to the number of unemployed falling significantly as workers left the labor force.

Unemployment Rate Falls as Employment-Population Ratio Declines, by pgl: BLS reports even more job losses in July:

Nonfarm payroll employment continued to decline in July (-247,000), and the unemployment rate was little changed at 9.4 percent

But the unemployment rate was 9.5 percent in June. Had the Administration been Republican, Lawrence Kudlow would be hailing this report as good news. Paul Krugman offers a different tone:

Some readers have asked how it’s possible for unemployment to fall when the economy is still losing jobs, albeit at a slower rate. The answer is a bit annoying. First, the jobs number and the unemployment number are based on different surveys — a survey of establishments in the first case, a survey of households in the second. Sometimes employment rises by one measure while falling by the other, although it happens that this month there isn’t much difference in the jobs number.

The household survey also showed job losses – with its figure being 155,000, which drove the employment-population ratio down from 59.5% to 59.4%. The labor force participation rate, however, also fell from 65.7% to 65.5%. The employment picture got a little worse last month or as Paul concludes:

the employment situation is drifting down, but not plunging — occasional mixed signals are likely. No big deal. The basic story is that things are sort of stabilizing — but they’re definitely not improving yet.

Finally, policymakers should look at the numbers the way Michael Mandel does and plan accordingly. It's far to soon for policymakers to ease up, and in fact, they ought to planning for more stimulus in case this is correct:

The Calm before the Storm?, by Michael Mandel: This morning’s jobs report seemed to show a firming-up of the labor market, with the unemployment rate dropping a tad, from 9.5% to 9.4%. Job losses have slowed too, down only 247,000 in July.

But one month’s numbers do not make a recovery. I’m betting that this may be just a temporary pause before the labor market worsens again towards the end of 2009. What happened is that the government has poured an incredible amount of money into the economy, through both monetary and fiscal stimulus. Policymakers have managed to blunt the downward spiral, which is a tremendous achievement. No depression on Bernanke’s watch.

But consumers are still cutting back, and the personal savings rate still has more to rise. I would treat this as the eye of the hurricane, with more yet to come.

Lucas Roundtable: Ask the Right Questions

In The Economist, Robert Lucas responds to recent criticism of macroeconomics ("In Defense of the Dismal Science"). Here's my entry at Free Exchange's Robert Lucas Roundtable in response to his essay:

Lucas roundtable: Ask the right questions, by Mark Thoma: In his essay, Robert Lucas defends macroeconomics against the charge that it is "valueless, even harmful", and that the tools economists use are "spectacularly useless".

I agree that the analytical tools economists use are not the problem. We cannot fully understand how the economy works without employing models of some sort, and we cannot build coherent models without using analytic tools such as mathematics. Some of these tools are very complex, but there is nothing wrong with sophistication so long as sophistication itself does not become the main goal, and sophistication is not used as a barrier to entry into the theorist's club rather than an analytical device to understand the world.

But all the tools in the world are useless if we lack the imagination needed to build the right models. Models are built to answer specific questions. When a theorist builds a model, it is an attempt to highlight the features of the world the theorist believes are the most important for the question at hand. For example, a map is a model of the real world, and sometimes I want a road map to help me find my way to my destination, but other times I might need a map showing crop production, or a map showing underground pipes and electrical lines. It all depends on the question I want to answer. If we try to make one map that answers every possible question we could ever ask of maps, it would be so cluttered with detail it would be useless, so we necessarily abstract from real world detail in order to highlight the essential elements needed to answer the question we have posed. The same is true for macroeconomic models.

But we have to ask the right questions before we can build the right models.

The problem wasn't the tools that macroeconomists use, it was the questions that we asked. The major debates in macroeconomics had nothing to do with the possibility of bubbles causing a financial system meltdown. That's not to say that there weren't models here and there that touched upon these questions, but the main focus of macroeconomic research was elsewhere.

One major debate, for example, was the rate at which the macroeconomy returns to its long run equilibrium after a shock. Both New Keynesians and Chicago type equilibrium theorists believed the economy was always moving in the right direction—toward long-run equilibrium—the question was simply how fast that movement occurred and whether there was any role for policy to help the process along. Neither side of the debate seriously considered the possibility that the economy would continue to move away from its long-run equilibrium outcome for a substantial period of time—for years—as a housing price bubble developed, and that once the bubble popped the interconnectedness of financial markets would cause the problem to spread in a falling domino fashion that would throw the entire economy into a deep recession.

The interesting question to me, then, is why we failed to ask the right questions. For example, notice Mr Lucas' defence of the simulations that failed to predict the crisis:

[T]he simulations were not presented as assurance that no crisis would occur, but as a forecast of what could be expected conditional on a crisis not occurring. Until the Lehman failure the recession was pretty typical of the modest downturns of the post-war period... Mr Mishkin’s forecast was a reasonable estimate of what would have followed if the housing decline had continued to be the only or the main factor involved in the economic downturn. After the Lehman bankruptcy, too, models very like the one Mr Mishkin had used, combined with new information, gave what turned out to be very accurate estimates of the private-spending reductions that ensued over the next two quarters.

I don't think we should be very impressed with the argument that once policymakers knew the economy was headed downward, the models were able to predict that the economy was headed downward. Further, even after it was known where the economy was headed, the models seriously underestimated the magnitude of the decline, and that led to an inadequate policy response.

But the important question is why policymakers didn't take the possibility of a major meltdown seriously. Why didn't they deliver forecasts conditional on a crisis occurring? Why didn't they ask this question of the model? Why did we only get forecasts conditional on no crisis? And also, why was the main factor that allowed the crisis to spread, the interconnectedness of financial markets, missed?

It was because policymakers couldn't and didn't take seriously the possibility that a crisis and meltdown could occur. And even if they had seriously considered the possibility of a meltdown, the models most people were using were not built to be informative on this question. It simply wasn't a question that was taken seriously by the mainstream.

Why did we, for the most part, fail to ask the right questions? Was it lack of imagination, was it the sociology within the profession, the concentration of power over what research gets highlighted, the inadequacy of the tools we brought to the problem, the fact that nobody will ever be able to predict these types of events, or something else?

It wasn't the tools, and it wasn't lack of imagination. As Brad DeLong points out, the voices were there—he points to Michael Mussa for one—but those voices were not heard. Nobody listened even though some people did see it coming. So I am more inclined to cite the sociology within the profession or the concentration of power as the main factors that caused us to dismiss these voices.

And here I think that thought leaders such as Robert Lucas and others who openly ridiculed models they disagreed with have questions they should ask themselves (e.g. Mr Lucas saying"At research seminars, people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another", or more recently "These are kind of schlock economics"). When someone as notable and respected as Robert Lucas makes fun of an entire line of inquiry, it influences whole generations of economists away from asking certain types of questions, some of which turned out to be important. Why was it necessary for the major leaders in macroeconomics to shut down alternative lines of inquiry through ridicule and other means rather than simply citing evidence in support of their positions? What were they afraid of? The goal is to find the truth, not win fame and fortune by dominating the debate.

We need to take a close look at how the sociology of our profession led to an outcome where people were made to feel embarrassed for even asking certain types of questions. People will always be passionate in defense of their life's work, so it's not the rhetoric itself that is of concern, the problem comes when factors such as ideology or control of journals and other outlets for the dissemination of research stand in the way of promising alternative lines of inquiry.

I don't know for sure the extent to which the ability of a small number of people in the field to control the academic discourse led to a concentration of power that stood in the way of alternative lines of investigation, or the extent to which the ideology that markets prices always tend to move toward their long-run equilibrium values caused us to ignore voices that foresaw the developing bubble and coming crisis. But something caused most of us to ask the wrong questions, and to dismiss the people who got it right, and I think one of our first orders of business is to understand how and why that happened.

There are other entries from (I'll update the list as more are added):

Some successes, some failures by Tyler Cowen
Mind the frictions
by Markus Brunnermeier
A change in tune
by Brad DeLong